Did you know that when you pass away and leave your super to your non-dependent children as a lump sum, they may be liable to pay tax on that super death benefit?
To save or minimise this tax liability, some people who have been diagnosed with a terminal illness decide to withdraw their super in full, just prior to their death and have it deposited into their personal bank account.
At first glance, this may come across as a tax minimisation arrangement. Given the uncertainty around the timing of death, even with a terminal diagnosis, it can be difficult to plan for. But given many Australians die with a substantial amount left in their super account, it’s a strategy worth exploring if you find yourself in these difficult circumstances.
If your non-dependent children or any other non-dependent beneficiaries ultimately inherit your super death benefit, then there are ways to minimise their tax liability and keep the Australian Taxation Office (ATO) onside.
First, I’ll look at how this strategy works in theory and explain the ATO’s view before moving on to practical applications for super funds.
How super benefits are taxed
Before you embark on any estate planning, it’s important to understand the different tax components of your super accumulation and/or pension account, namely tax-free, taxable taxed and untaxed components and how they are taxed after your death.
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It is the taxable components (taxed and untaxed elements) that are taxed after your death when they are passed on to non-dependent beneficiaries. Dependants (including your spouse, children under 18, and any person completely financially dependent on you) don’t pay tax on your super death benefit.
Adult non-dependent children pay a maximum of 15% plus Medicare Levy (currently 2%) on the taxed element and 30% plus Medicare Levy (or up to 32%) on the untaxed element. If the benefit is first paid into the estate before being distributed to non-dependent beneficiaries then the same tax rates are used but Medicare Levy does not apply.
To give a quick example, say you passed away at 90 with a balance of $500,000 in your account-based pension that had a taxable component of $200,000. If your non-dependent child was to receive the death benefit directly from your super fund, they would have a tax liability of $34,000 (15% tax plus 2% Medicare levy) making their net death benefit lump sum $466,000.
Using the recontribution strategy to reduce tax on your super benefits
If you are eligible, then financial advisers generally recommend the recontribution strategy to help reduce your taxable components to reduce this potential issue for your non-dependent beneficiaries in the future.
As the recontribution strategy cannot work under every situation (for example, if you are over 75), there is a high possibility you may still have a taxable component in your super in later life. In such cases, financial advisers usually advise clients who are seriously ill or on their death bed to withdraw all their super, if possible, and let it sit in their personal bank account. This is because that cash no longer remains in the super system and instead forms part of the estate. Cash is not taxable to your estate or your beneficiaries upon your death.
However, this strategy is not always straightforward and the ATO may have different views on it.
The main factor that determines whether withdrawing super on your death bed will be taxed or not is whether that money is considered a member benefit or a death benefit.
Need to know
The Income Tax Assessment Act 1997 states that a member benefit is “a payment made to a person because they were a superannuation fund member”. In contrast, a death benefit is “a payment made to a person after another person’s death because the deceased was a superannuation fund member”.
As you can see in the case studies below, issues can arise when arrangements are made to withdraw super prior to death but the money doesn’t hit the member’s personal bank account until after they die.
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Note that the case studies are for general information only. The ATO states that for advice on specific circumstances, the executor or legal representative of a member’s estate can apply for a private ruling.
Case study 1 – If you have an SMSF
Adam and his adult son Dave are the members and trustees of their SMSF. Adam’s super is in an account-based pension and he has nominated Dave as the sole beneficiary of his super death benefit. Dave is a non-dependent adult child so when Adam dies, his death benefit will need to come out of the SMSF and paid to Dave. When this happens, Dave will be liable to pay 15% tax plus 2% Medicare levy on the taxable component of Adam’s death benefit. Adam is terminally ill and is on his death bed.
Adam makes a written request to the SMSF trustees (he and Dave) for a full withdrawal of his member balance from the SMSF, which is granted. Before the benefit payment is paid, Adam passes away. A few days later, the benefit hits Adam’s personal cash account.
As the remaining trustee, Dave now needs to determine whether the benefit payment was a member benefit or a death benefit.
In the ATO’s view, if a member requested an amount to be paid from their fund before they died, but died before they received it and the super fund trustees were aware of the death, then it is most likely considered to be a death benefit. In very limited circumstances it may be a member benefit. This is because in an SMSF, the members and trustees are generally spouses or family members who would be aware of a particular member’s death.
If Adam’s benefit was paid and credited to his personal bank account before he died, then no tax would have been payable on the cash sum.
Super tip
The important issue for SMSFs is the evidence that can be produced to prove intention. That is, if the SMSF trustees had received Adam’s withdrawal request and made the decision to make the member benefit payment prior to his passing, AND they can prove this with written documentation, then it could be argued that the payment was actually a member benefit payment and not a death benefit payment.
Case study 2 – If you have an APRA fund (e.g. industry super fund or retail super fund)
Adam is a member of an Australian Prudential Regulation Authority (APRA) regulated super fund where he has an account-based pension. Adam has nominated his estate as the beneficiary of his super death benefits. Adam becomes terminally ill and makes a request to his fund for release of his super benefits.
Before the benefit payment is made by the super fund, Adam passes away. The super fund’s trustee is only informed of Adam’s death after the benefit is paid in to Adam’s personal cash account.
Given the trustee of the super fund had no knowledge of Adam’s death at the time of making the benefit payment, the payment is most likely to be considered a member benefit. This means that Adam’s estate will not have to declare the payment as taxable income when it is being directed to a non-dependent beneficiary, and no tax is payable because the benefit is not a death benefit.
While there is no one size fits all approach in these situations, the super fund trustee’s knowledge of the member’s death plays a crucial role.
Q: Can someone with your power of attorney deal with your super while you are alive, so pull it out before your death?
A: It is possible for a member of a super fund to appoint a person under an enduring power of attorney (EPoA) to make decisions on their behalf in relation to their financial affairs which includes superannuation.
Under the EPoA, the member can set the terms of the power to commence at a particular time or for particular matters. For example, an EPA may activate if the member is mentally incapacitated and only in relation to their financial affairs.
For an attorney to withdraw super benefits, it will continue to be subject to the superannuation legislation which requires a condition of release to be satisfied prior to the payment being permitted. For example, a condition of release is satisfied if the member is retired for superannuation purposes after reaching their preservation age, is permanently disabled, has reached age 65 or they have died.
Q: I have been asked to become an attorney for someone with a will who lives in Tasmania. The Power of attorney is currently being reviewed. I am concerned about the solicitor’s advice that there is no need for a “conflict” clause, as I am also one beneficiary. My specific concern is that I want the power to withdraw the person covered by the POA’s pension balance and put it in their bank account ahead of their expected imminent death. This would be done to avoid the taxation on the taxable component of the pension fund balance – i.e. benefit the beneficiaries, not the person with the pension. Is the superannuation fund likely to consider this a conflict of interest and/or block the transaction? Can you provide some examples where this has been an issue? I want to revert with some information to discuss with the solicitor.
A: We are not aware of any super funds preventing a power of attorney from withdrawing superannuation benefits prior to the member’s death. It is relatively common for attorneys to do so for the reason you have explained. It is also common for that attorney to be the member’s child or another person who would be liable for tax on the amount if it was instead paid to them from the fund after the member’s death.
Whether a ‘conflict’ clause is necessary is a matter for your solicitor.
However, no transaction can be guaranteed. Super funds do have a responsibility to protect their members from fraud and elder abuse. Controls designed to prevent fraud and abuse could potentially delay a transaction beyond the member’s death. If the member dies before payment, the amount generally becomes a death benefit that can no longer be paid to the member. It must instead be paid directly to dependants or to the member’s legal personal representative (the executor of their estate) and tax will be payable where applicable.
To reduce the risk of delays, you can consider
lodging the power of attorney with the fund to hold on file in advance, to prevent delays accepting the document at the time a payment is required.
having the member notify the fund in writing of their wish for benefits to be cashed in the event of their imminent death and that the attorney is authorised to make such a request on their behalf in future.
ensuring the document is an enduring power of attorney, to secure its effectiveness should the member lose decision making capacity in future.
Aakash Mehta is a financial adviser and has been working in the financial planning profession for more than 7 years. He has an undergraduate degree in commerce, a post-graduate degree in international finance and a diploma in financial planning. His day-to-day work exposes him to real life financial planning issues around superannuation, retirement, insurance and estate planning, and he contributes to SuperGuide by writing case studies and articles on various financial planning strategies.
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